Question

You would expect an increase in interest expense to______ the amount of taxes paid while an increase in dividends paid_________ the amount of taxes paid.

Answer 1

Question is a fill in the blanks question.

I will split up the entire statement into 2 parts for the purpose of simplicity of your understanding.

1) Statement: You would expect an increase in Interest Expense to ________ the amount of taxes paid

Answer: Reduce

Reasoning: Interest expense is a tax-deductible expense. That means, from your revenue, you deduct interest expense before arriving at your profit. You pay taxes on profit. So, a higher interest expense will reduce your profit and therefore will reduce the taxes to be paid by you. (In a case where you have a loss, Interest Expense increases the amount of Losses and hence increases the tax benefit that can be availed in the future).

2) Statement: While an increase in Dividends paid ______ the amount of taxes paid.

Answer: Does not impact

Reasoning: Dividends are a means of distribution of profits to the company's shareholders. In the income statement, they find their place after Profits (Profit after tax). Hence, they do not impact the taxes paid by the Company on its Profits.

However, you must keep in mind that certain countries reuire companies to pay DDT on Dividends distributed to shareholders. This is DDT paid on behalf of shareholders and not a part of the Company's Taxes.